22 December 2008

Bystanders to this financial crime were many
By Nassim Nicholas Taleb and Pablo Triana

Published: December 7 2008 19:18

Taleb

On March 13 1964, Catherine Genovese was murdered in the Queens borough of New York City. She was about to enter her apartment building at about 3am when she was stabbed and later raped by Winston Moseley. Moseley stole $50 from Genovese’s wallet and left her to die in the hallway.
Shocking as these details surely are, the lasting impact of the story may lie elsewhere. For plenty of people reportedly witnessed the attack, yet no one did much about it. Not one of the almost 40 neighbours who were said to have been aware of the incident left their apartments to go to Genovese’s rescue.
Not surprisingly, the Genovese case earned the interest of social psychologists, who developed the theory of the “bystander effect”. This claimed to show how the apathy of the masses can prevent the salvation of a victim. Psychologists concluded that, for a variety of reasons, the larger the number of observing bystanders, the lower the chances that the crime may be averted.

We have just witnessed a similar phenomenon in the financial markets. A crime has been committed. Yes, we insist, a crime. There is a victim (the helpless retirees, taxpayers funding losses, perhaps even capitalism and free society). There were plenty of bystanders. And there was a robbery (overcompensated bankers who got fat bonuses hiding risks; overpaid quantitative risk managers selling patently bogus methods).

Nassim Taleb ‘The Risk Maverick’: We May Be Experiencing Something That Is Vastly Worst

This insightful PBS News Hour Interview with great thinkers in Nassim Nicolas Taleb (author of Black Swan: The Impact of the Highly Improbable) and Fooled by Randomness and Benoit Mandelbrot (The (Mis)Behavior of Markets)

Some noteworthy quotes from the interview:

From Nassim Taleb:

“The banking system the way we have it is a monstrous giant built on feet of clay and that topples we’re gone. Never in the history of the world have faced so much complexity combined with so much incompetence and understanding its properties.

“We live in a world that is way too complicated for our traditional economic structure it’s not as resilient as it used to be we don’t have slack it is over optimized.”

“Let me tell you what is happening in the ecology of the banking system, there is swelling of large banks because it vastly more optimal to have one large bank than ten small banks. It’s more efficient. And that consolidation is putting us at risk because when one large bank makes a mistake, it’s ten times worst than a small bank making a mistake.”

“I think we may be experiencing something that is vastly worst than we think it is.”

“The network effect of globalization means that a shock in the system can have much larger consequences.”

From Benoit Mandelbrot:

“The word turbulence is one which is actually common to physics, social sciences to economics, everything about turbulence is enormously complicated not just a little bit complicated not just one year more school it’s enormously complicated.

“The basis of weather forecasting is looking from the satellite and seeing the storm coming but not predicting that the storm will form…the behavior of economic phenomenon is far more complicated than the behavior of liquid and gasses.”

“Tools have been developed which assume changes are always very small,…then nothing bad happens, if several of them come together bad things can happen and the theory does not take account of that. And the theory does not take account of very large and sudden changes in anything, the theory thinks that things move slowly gradually and can be corrected when in fact they may change extremely brutally.”

My comment: Both Mr. Taleb and Mr. Mandelbrot seems to be worrying about the US dollar based global banking system which is getting to be “too big to fail”.

With the US government’s increasing influence in the consolidation of the banking sector, directly and indirectly, where deal making has surpassed $3 trillion, such risk concerns may not be exaggerated.
Courtesy of Wall Street Journal/dealogic